Korea's Biggest Fund Has Got to Think Small

It's time the world's third-largest pension fund looked further than chaebol.

It's been more than 12 months since the head of South Korea's National Pension Service was arrested in a corruption scandal that led to President Park Geun-hye's impeachment, but little has changed. Some 70 percent of the fund's stock portfolio is in large caps, mainly family-run conglomerates such as Samsung Electronics Co. and SK Hynix Inc. Small caps account for just 9.2 percent of equities allocation, down from 17 percent two years ago.

Thinking Big

Korea's National Pension Service owns very few Kosdaq companies

Data: Bloomberg, local media; graphic by Bloomberg Gadfly

That may be about to change.

President Moon Jae-in is keen to develop the nation's secondary stock board, the Kosdaq, where the bogeyman chaebol aren't listed. New incentives unveiled last week propelled the benchmark to its highest since 2002, and there are plans for a new index with a blend of Kospi and Kosdaq firms, making it easier for passive funds to follow and invest in the junior bourse.

Small Really Is Beautiful

South Korea's Kosdaq has been outperforming the Kospi this year amid policies to develop the junior board

Data: Bloomberg; graphic by Bloomberg Gadfly

Seoul is now pushing the NPS to add more Kosdaq companies, potentially going as high as 10 percent from its current 2 percent domestic stock allocation.

That might be just as well, considering some analysts have begun revising Samsung's earnings downward. Last year, the Kospi soared 22 percent in won terms with the electronics giant alone contributing 38 percent of that.

Peak Performance

Samsung's share price is sensitive to earnings, and recently, analysts have begun to revise their estimates downward

Data: Bloomberg; graphic by Bloomberg Gadfly

What's more, at a time when the U.S. Food & Drug Administration is seen quickening the pace of biosimilar drug approval, the NPS's paltry allocation to healthcare stocks stands out. Shares of Celltrion Inc., the Kosdaq's biggest company, are up 58 percent this year, for example.

There is one caveat. To buy more Kosdaq stocks, the NPS will have to work much harder and become an active share picker. Following the index's weighting would see it buy mainly Celltrion and Celltrion Healthcare Co., simply because they now constitute more than 20 percent of the Kosdaq's total market cap. Of the some 1,266 companies on the Kosdaq, just 120 have a daily trading value north of $10 million. Passive buying by a juggernaut fund would distort the market.

But it's time for more shareholder activism. Corporate governance in South Korea is lacking, in part because of chaebol dominance and also because the NPS doesn't use its balance sheet to foster change. Whereas Japan's Government Pension Investment Fund is already heavily into ESG investing, the NPS is just getting started with a draft stewardship code.

Day traders that quit the Kosdaq for digital currencies may come flooding back should the government indeed ban cryptocurrency speculation. But for the nation's junior bourse to really take off, it needs a lift from its biggest pension fund.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.